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11th Circuit Affirms Tax Court Decision Regarding Fraud by Preparer

Posted on July 22, 2019

The Eleventh Circuit, in Finnegan v. Commissioner, No. 17-10676 (11th Cir. 2019), aff’g T.C. Memo. 2016-118, affirmed the Tax Court’s decision that the statute of limitations period for assessment remained open due to the fraud of the preparers with the intent to evade taxes. Les blogged the earlier decisions regarding the case here and here. The Eleventh Circuit noted the adverse decision of the Federal Circuit which we have discussed here. For the reasons discussed below, the 11th Circuit’s decision does not provide support for the proposition that fraud by someone other than the taxpayer can hold open the statute of limitations nor does it provide support for those arguing that fraud by a third party cannot hold open the statute of limitations. It provides support for the proposition that a taxpayer should timely raise an argument at the lower court if it wants to preserve the argument on appeal. Both sides must wait for the next case to see where this issue will go.

The Finnegans hired someone to prepare their returns. The individual they hired put false information on their returns which they did not catch. Eventually, the IRS caught the return preparer and successfully prosecuted him. After prosecuting the preparer, the IRS looked to the Finnegans to pay the deficiency in tax that had accumulated over eight years of fraudulent return preparation. The Finnegans argued that the statute of limitations had long since expired by the time that the IRS sought to get them to pay. The IRS argued that the fraud on the return held open the statute of limitations. The 11th Circuit sustains the decision of the Tax Court that fraud by the preparer can hold open the statute of limitations.

The case began as many fraud cases do – with an informant. The taxpayers chose a preparer who, together with associates, prepared about 800 returns a year for 11 years basically all of which had similar fraudulent features. The preparer used large partnership losses to generate lower tax liabilities. The features used by the preparer in the bulk of the returns prepared existed in the Finnegans’ returns. When the IRS cracked the preparer’s fraudulent scheme, it brought a criminal action against him to which he pled guilty and then he started singing in order to reduce his sentence. He testified that “[e]ach and every one” of the returns prepared “contained[ed] some fraudulent entries.”

At the Tax Court trial phase, the taxpayers did not challenge the court’s precedent on the effect of third party fraud on the statute of limitations. They conceded that the case of Allen v. Commissioner applied but argued that the IRS lacked sufficient evidence of the fraudulent nature of their return. After the parties tried the case and submitted their briefs, the Federal Circuit decided BASR Partnership v. United States, 795 F.3d 1338 (Fed. Cir. 2015). The IRS notified the court of the decision which took the opposite position as Allen v. Commissioner, 128 T.C. 37 (2007)(the Tax Court’s precedential opinion regarding fraud by the preparer). Petitioners did not contend the Tax Court should revisit Allen after the adverse Circuit precedent in BASR.

After the Tax Court found for the IRS on the statute of limitations issue, petitioners obtained new counsel. The new lawyers filed a motion for reconsideration arguing that the Tax Court erred in not revisiting the Allen decision and that the Tax Court should overturn its decision in that case. To avoid the problem that the taxpayers had waived this argument before they arrived on the scene, the new lawyers argued that it would have been unethical for the taxpayers to argue that Allen did not apply until the Federal Circuit ruled in BASR. The Tax Court ultimately rejected this and similar arguments in the motion for reconsideration.

On appeal the taxpayers argued that the fraud exception is only triggered by a taxpayer’s actions and that the Tax Court erred by admitting the return preparer’s out of court statements. With respect to the Allen case the 11th Circuit found that the taxpayers waived this argument. After explaining in some detail why it found the taxpayers waived the argument, the court stated that taxpayers’ best argument “is that we should exercise our discretion and not enforce the waiver doctrine.” The court notes that it has provided five special circumstances in which it will consider a new argument on appeal. It works through those five exceptions and finds they do not apply. Then the court finds that the taxpayers’ argument regarding the Tax Court’s decision to admit the out of court statement was not an abuse of discretion.

Because it sustains the Tax Court on a procedural rather than a substantive basis, the Finnegan case does not provide much support for either the IRS or those seeking to keep a third party’s fraudulent actions from suspending the statute of limitations on assessment. This issue will continue to cause parties to seek circuit level review. The case makes clear that a frontal attack on Allen should occur at the Tax Court level. No big surprise there. The 11th Circuit provides no clues how it might have ruled had taxpayer raised the issue at the Tax Court.

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